Tuesday, September 18, 2007

Altria After The Spin. What Can Investor's Expect?

Some thoughts on what Altria (MO) investors can hope for after PMI is spun off.

The Dividend:

CEO Louis Camilleri said when the upcoming breakup was announced that the dividend of the two companies "would at least" equal the current one which after the recent 8.7% increase sits at $3.00 per share (4.5% yield). The key is his use of the term "at least". Camilleri has in the past telegraphed the future intentions of Altria while not committing the company to anything extraordinary. This is one of those occasions. Camilleri said "Going forward, I would anticipate that Altria and PMI would have net earnings payout ratio targets of around 75% and 65%, respectively." 2006, PMI generated operating cash flow of $6.2 billion, while remaining Altria (excluding Kraft) generated $3.7 billion and both will enjoy very strong balance sheets. What could happens to the dividend? See below after share repurchase section.

Cost Savings

Currently Altria is a bloated pig here. Their cost per 1,000 cigarettes produced is 10% higher that rival Reynolds American (RAI). Altria is taking steps to alleviate that with the closing of their NY city headquarters. The company estimates an annual savings from the move of about $250 million. The separation of the two entities (PMI and PMUSA) also eliminates an additional bureaucratic layer that Reynold's, who has no international operations is currently without creating additional savings.

Share Repurchases / Debt

Camilleri said one of the advantages of the breakup would be, "A more optimal and efficient capital allocation to enhance shareholder value coupled with greater financial flexibility resulting from an increase in the combined debt capacity of both entities.." and "both companies will have the flexibility and capacity to further enhance shareholder value through share repurchases." Great but how much? As of June 30th, Altria sits on $6 billion in cash, $4 billion of debt and should generate almost $15 billion in cash from operations this year, meaning as things stand now, debt is irrelevant. How much could it take on? Currently Altria has a long term debt to equity ration of .27 vs 1.25 for the industry. If we bring Altria up to the industry average, we get to a combined debt level of almost $30 billion dollars which would enable the company to repurchase 20% of the outstanding shares.

Here is the kicker. If they do that, and keep the total dividend payout at it's current $6.3 billion annual level (which would be fully supported by operations), this would enable them to distribute approximately an additional 75 cents per share to shareholders, just from the number of outstanding share reduction. This would bring the combined yield of the two entities to a whopping 5.6%.

Now, none of this takes into consideration share appreciation that is inevitable due to the EPS increase associated with the repurchases. Will all of this happen? Not right away of course but rest assured, Altria has been waiting to reward shareholders for some time, I expect all of the following to happen to some degree early next year .


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